Rabobank: An Echo Of The 1970s

By Michael Every of Rabobank

We are all focused on US inflation numbers today. So focused, in fact, that some of us think we know what the number already is, at least compared to the consensus of 0.4% m/m, 7.2% y/y. There was a strong response to the US 10-year auction yesterday, with indirect bidders (i.e., nudge-nudge-wink-wink foreign central banks) stepping up, which does not suggest much fear of an upside surprise pushing the US 10-year yield through the psychological 2% level. There is also market chatter of whispers that today will see a CPI downside surprise –so only 7.1% y/y? Such non-inflationaryness!!– for the first time in a while.

I get this is important. Another upside surprise and the odds of the Fed going 50bp in March would increase. A downside surprise and ‘inflation is over!’ memes will build, helped by ‘Too Big to Sail’ supply-chain logjams easing slightly at LA/LB port. (To be expected at this time of year by the way: and ready to change for the worst due to any number of trigger points).

But really, given all the statistical deep-tissue massaging going on –akin to the neck-cracking Thailand’s Wat Po school used to do before it was dropped for health and safety reasons– does anyone think inflation would actually be ‘over’ on the back of a one-tick downside surprise today? Of course, base effects alone say the y/y inflation headline rate will ease ahead. Yet in energy and in food in particular, ‘what goes up does not have to come down’, and 7% headline inflation can still be followed by 3% and still not mark any kind of win for central banks or consumers.

The key issue is if a workforce already either moving into crypto and out of their jobs, into retirement, onto the streets, or into trucks, is going to swallow a double-digit drop in real incomes or will push for much higher nominal wage growth. No wage growth suggests a nasty outcome, as you cannot spend what you don’t have. Wage growth suggests an echo of the ‘70’s. So the 2022 (and 2023) inflation story is far from over whatever happens today.

At the same time, the same people who focus intently on the minutiae of a 0.34% or a 0.35% reading in US inflation are not even glancing on the start of Russian military exercises next to Ukraine that could indicate an invasion according to the US sources markets are supposed to listen to. That is despite the fact that any invasion would force changes to everybody’s inflation forecasts. The logic of concentrating on the odds of a 0.01% difference in the m/m change in the CPI index as opposed to the bright-pink-rhino tail risk of 130,000 men, tanks, ships, planes, artillery and missiles, etc., eludes me. But you do you, Wall Street.

Ominously, Russia has already declared most of Ukraine’s Black Sea and Sea of Azov coastlines closed for missile drills from February 13-19. That map is an overlay with the one showing where fighting in Ukraine could hit the global grains trade, even though winter is not a worrying time for this to be happening. Moreover, there are other things to note with concern.

• First, Putin’s luxury superyacht, ‘Graceful’, just hurriedly left Germany before finishing repairs, according to local media. It did not require any historic bridges to be demolished to do so.

• Second, Ukraine almost certainly won’t accept the Minsk accords Russia and France want it to, even if backed by the EU, even if that were to be the united EU position. Experts say if Ukraine were forced to do so, the country would be thrown into chaos and likely splinter – again bringing Russia into the picture.

• Third, Russia has so far achieved nothing much beyond demonstrating the West is not united and the EU not capable of serious action (e.g., recent military flights taking cargo to Ukraine show 13-14 each from the UK and US vs. 1 from the EU). Will Russian troops just go home when military exercises officially end on 20 February, leaving Ukraine and NATO to rearm over the next few years? Russian military equipment could be stockpiled next to Ukraine (and stay in Belarus), meaning hostilities could restart quickly.

• Fourth, the Russian press make clear this issue is not going to go away. Ruslan Pushkov, a military analyst in Moscow, states even if Western concessions stall conflict for now, they will not hold longer term as “The West just doesn’t understand how much this is a question of life and death for us.” The Dean of the school of international relations at an elite Moscow university likewise argues, “I expect we’ll have this crisis with us, in various forms, for all of 2022, at least.” He sees it as just the start of a drawn-out, high-stakes phase of a Russian effort to change the European security architecture to a new form the West rejects. The aim, he believes, is to keep the threat of war ever-present, in order to harass war-averse Western leaders to negotiate. Yet continually threatening war and not acting could eventually see the West shrug – ironically, just like the market analysts who have a 0.01% difference in the m/m change in the US CPI index to worry about. What would Russia do then if it really is ‘a question of life and death’?

The key point is that we have significant room for market-moving upside or downside surprises today: and regardless of the US CPI print, the further out you look, the more that dynamic holds true.

(I would also like to apologise to the majority of readers who, even with translate functions, didn’t get the Russian punchlines yesterday. Both phrases were polite Soviet equivalents of very impolite US military acronyms to describe very bad situations that are not easily resolved.)